According to Lao Tzu, a wise Chinese philosopher, a journey of a thousand miles begins with the first step. Whatever your inspiration to start investing, whether it is a book, lunch with a friend or an introduction to a financial advisor nothing happens without your first contribution. The contribution plan you choose is a very powerful decision because it sets the course for your investment journey. It also happens to be one of the very few investment variables you are in direct control of. This is such an important area of wealth that you can search and read up on the “pay yourself first” discipline from many wise sources. This lifetime of contributions overview attempts to put some numbers behind this concept over the typical milestones in an investing career.
Seeding
Like a farmer planting seeds in the spring, a new investor must build a deposit base to deploy funds in a portfolio. At this stage, establishing the discipline of setting aside regular contributions is more important than the amount. For this reason, simplicity is key and 10% of net income works well. Whatever your income, 10% is easy to calculate and set aside. The assumption is that each investor is starting from zero. If you happen to have a lump sum start from an inheritance or other lump payout, good for you, but the process is still the same. At this stage consistent reinforcement is essential, so a monthly check-in is recommended. Whether you use software tools, a spreadsheet, or a regular meeting with your advisor a monthly check-in of your contribution rate and accumulating balance will motivate you to keep going.
Building
Once you have a base of funds to work with, the next step is to build a portfolio. Typical portfolios will have a mix of fixed income, stocks, real estate and infrastructure. The exact plan you deploy will be up to personal circumstances, but the journey is the same. The goal is to add to core positions and take advantage of dollar-cost averaging. At this stage, 10% is still a recommended contribution rate as is a monthly check-in. The rate also ensures those with a company matching RRSP program will get to take advantage of it, and those with pensions will be complimenting those long-term programs without overdoing it. This is still the early stages of an investing career, and the building of discipline is more important than the dollar amount. Whether you are on a fixed or variable income, 10% is easy to figure out, enough to fuel portfolio build-out and not enough to cramp a lifestyle.
Accumulation
The accumulation stage will be the longest leg of the journey for most investors. Potentially spanning a couple of decades, this is where life can push and pull and test finances. Maybe a large tax return comes in, or you make a big sale and cash a huge commission check. Or the transmission on your car drops out and the house needs a new roof. The scenarios are endless, but the challenge is the same. You will need to establish an upper and lower contribution rate to ride out some of the ups and downs. For this reason, a 5% floor and 15% ceiling make good sense. Getting a lump sum of money is exciting, and the temptation to add more than 15% might be there. Keep in mind that investing is simply delayed consumption. Live a little in the present, spend some money and have some fun and cap at 15%. If you are in an extended period of cash flow pressures, drop to 5%. It may not seem like much, but you are keeping the discipline of regular contributions and that is the critical point. Over the extended period of time you are accumulating, the highs and lows will likely be a wash. By establishing an upper and lower contribution limit that works for you makes the process automatic with little chance of self destruction.
Fine-tuning
Once you have built a portfolio and weathered some ups and downs in capital markets, some inevitable things will happen. You will learn about how the different investments in your portfolio perform over time and will want to add to some positions that work well. You may also have time to research and add some complementary investment ideas to your core holdings. All of these require a continuous flow of contributions to make happen. Investment structures also vary in terms of how they are bought - from mutual funds for as little as $50 to ETFs that make sense to add in larger amounts to manage trading costs. At this stage, having your contributions go directly into a cash wedge/account makes the most sense. As the balance increases monthly, it gives you time to decide on where your next purchase will be – your core holdings or a complimentary one.
De-Accumulation
Every journey has an endpoint, and this is where your contributions stop and your portfolio works for you. To get here, it took years of contributions for most of us! Pay yourself first is a foundational investment philosophy. For investors just starting out and trying to determine what that means, keep these four essential things in mind for contributions:
- Easy to calculate
- Aligns with employer matching or pension plans
- Monthly check-in to reinforce
- Set personal upper and lower limits
